The most important thing in brief
- Definition: Bonds are securities that entitle the holder to
repayment of the invested amount along with interest. Governments and
companies issue bonds to raise capital from the market.
- Types: Bonds are categorized based on factors like interest
structure, issuer, or terms. Common types include convertible bonds,
corporate bonds, and government bonds.
- Risk: Investing in bonds carries risks. The risk and return
depend on factors such as bond type, the issuer’s creditworthiness, and
overall market conditions.
Latest on Bonds and Fixed-Income Securities
As of January 2025, the average yield on ten-year German government bonds was 2.22% per year.
German government bonds are considered a relatively low-risk investment. To achieve higher
returns from individual bonds, investors must accept higher risks in bond trading. However,
bonds issued by entities with low credit ratings carry a significantly higher risk of
potential loss. As an alternative to government bonds, fixed-term deposits can be an
attractive investment option, offering deposit insurance and the potential for higher
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Definition: What Are Bonds and How Do They Work?
Bonds are exchange-traded securities that typically offer fixed interest payments and repay
the invested capital at the end of a set term. They are also commonly referred to as
"fixed-income securities," "debentures," or "notes."
Simply put, a bond represents a loan granted to the issuer. In return, the issuer agrees to
pay regular interest (coupon payments) throughout the life of the bond and repay the nominal
value at maturity.
Typical features of bonds include fixed interest rates and fixed terms. Issuers can be banks,
institutions, corporations, or governments. Investors may be individuals or institutions.
Bonds are assessed based on creditworthiness and categorized by rating agencies, ranging
from AAA (highest quality) to D (default).
Example: Bond Yield
In a fictional example, an investor purchases ten bonds with a face value of €100 each and an
annual interest rate of 3.00%. The term is ten years. The investor receives annual interest
payments totaling €30, and at maturity, the initial investment of €1,000 is repaid in full.
Definition: What Are Bonds and How Do They Work?
Bonds are exchange-traded securities that typically offer fixed interest payments and repay
the invested capital at the end of a set term. They are also commonly referred to as
"fixed-income securities," "debentures," or "notes."
Simply put, a bond represents a loan granted to the issuer. In return, the issuer agrees to
pay regular interest (coupon payments) throughout the life of the bond and repay the nominal
value at maturity.
Typical features of bonds include fixed interest rates and fixed terms. Issuers can be banks,
institutions, corporations, or governments. Investors may be individuals or institutions.
Bonds are assessed based on creditworthiness and categorized by rating agencies, ranging
from AAA (highest quality) to D (default).
Example: Bond Yield
In a fictional example, an investor purchases ten bonds with a face value of €100 each and an
annual interest rate of 3.00%. The term is ten years. The investor receives annual interest
payments totaling €30, and at maturity, the initial investment of €1,000 is repaid in full.
Bond Basics: Key Terms You Should Know
When researching bonds, you may encounter several technical terms. The following explains the
most important concepts:
- Nominal Value: The portion of total debt assigned to each bond. It
is repaid at the end of the term and is calculated by dividing the total issue
volume by the number of bonds issued.
- Issuance: The process of offering a bond is called an issuance or
offering. This can be done through self-issuance or via third parties.
- Issuer: The entity issuing the bond. This may include governments,
financial institutions, or non-financial corporations.
- New Issue: Bonds that are offered to the market for the first time
and have not been previously traded.
- Coupon: The annual interest paid by the issuer to the bondholder.
It is influenced by factors like the issuer's credit rating, maturity, collateral,
and the general interest rate level. The coupon should not be confused with yield,
and there is no compound interest in bonds.
- Yield: While the coupon represents the interest rate, the yield
reflects the actual return, factoring in price, interest, and fees — also known as
effective yield.
- Market Price: The current trading value of a bond, usually quoted
as a percentage of its nominal value (100% = face value). Important if selling
before maturity.
- Redemption Price: The price at which the bond is repaid at
maturity, typically 100% of its nominal value.
- Issue Volume: The total capital raised by issuing the bonds.
Dividing this by the number of bonds gives the nominal value per bond.
- Credit Rating: The creditworthiness of the issuer, used to evaluate
risk. Bonds are rated from investment-grade to speculative.
- Currency Fluctuations: Investing in bonds denominated in foreign
currencies (e.g., USD) carries exchange rate risk, which can impact returns.
- Bonds: "Bonds" is simply the English term for "Anleihen" and may be
used interchangeably.
What Types of Bonds Are There?
Bonds are categorized based on their interest structure, the type of issuer, or other
characteristics such as their structure. By interest type, they include classic fixed-rate
bonds, zero-coupon bonds, variable interest bonds, and low-yield bonds. Issuer-based
categories include government bonds and corporate bonds. Bonds also differ by credit rating,
sector, and the issuer’s country. Other classifications include foreign currency bonds,
profit participation rights, subordinated bonds, convertible bonds, and structured bonds.
Government Bonds
Government bonds are issued by sovereign states like Germany. Their terms can range from a
few months to over 30 years. Bonds from financially strong countries are considered
relatively low-risk investments compared to other bond types.
Corporate Bonds
Corporate bonds are issued by companies to raise capital. The yield depends on the company’s
credit rating and bond term. Typically, the shorter the term and the stronger the company,
the lower the interest payments tend to be.
Convertible Bonds
Convertible bonds are hybrid instruments that combine features of bonds and stocks. They can
be converted into shares at a predetermined price. Depending on their structure, they may
behave more like bonds or like stocks.
Covered Bonds (Pfandbriefe)
Covered bonds are corporate bonds secured by specific assets, such as mortgage loans. Due to
their backing, they generally offer lower interest rates. In case of default, these bonds
are protected by the pledged collateral.
Subordinated Bonds
Subordinated bonds are mostly issued by banks or insurance companies. In the event of
insolvency, investors are paid only after all other creditors. Due to this higher risk,
these bonds often offer higher returns.
High-Yield Bonds
High-yield bonds are issued by entities with lower credit ratings — typically rated BB or
lower by rating agencies. These government and corporate bonds offer higher return potential
but come with significantly increased risk.
Can a Bond Be Sold Before Maturity?
Bonds can be sold before their maturity date. This can be attractive if the bond price has
increased, allowing potential profits or early access to invested funds. Bond prices work
similarly to stocks, mutual funds, or ETFs. Despite fixed interest payments and repayment of
the nominal value at maturity, bond prices fluctuate based on the issuer’s credit rating.
Bond prices are quoted as a percentage of face value, not in euros or dollars. As maturity
approaches, the price typically converges to the nominal value since repayment is imminent.
Example:
If a bond with a nominal value of €100 falls to 93% and is sold, it yields €93. If the price
rises to 105% and is sold, it returns €105, generating a €5 profit.
What Risks Are Associated with Bonds?
All bonds carry risk, which varies depending on the bond type. Risk is assessed based on the
issuer’s creditworthiness. Companies with poor credit ratings present greater risks than
those with strong ratings. The higher the risk (i.e., the lower the credit rating), the
higher the interest rate offered.
Example: Risks of Corporate and Government Bonds
Bonds from the Federal Republic of Germany offer relatively low yields because a default is
considered highly unlikely. In contrast, bonds from emerging or developing countries carry a
higher default risk, which is compensated by higher yields. The same principle applies to
corporate bonds. Mid-sized company bonds tend to offer higher returns due to higher risk,
whereas large industrial or corporate bonds offer lower yields. Convertible and subordinated
bonds also vary in risk depending on the issuer's credit rating.
Bonds at a Glance: Advantages and Disadvantages
As an investment, bonds offer both advantages and disadvantages. Here's an overview of the
key pros and cons:
Advantages of Bonds
- Regular and predictable interest payments
- Can stabilize and diversify a stock portfolio
- Low-risk investment option
- Can be sold before maturity
- Potential returns from price gains
Disadvantages of Bonds
- Possible price losses — may be worth less at sale than at purchase
- No deposit protection
- Risk of total loss
Investing in Bonds – How and Where Are Bonds Traded?
Bonds are traded directly through banks or on the stock exchange. To invest in bonds, an
investment account (securities depot) is required. Transaction fees apply when trading
bonds. In addition to individual bonds, investors can also purchase bond funds, also known
as fixed-income funds. These funds invest in multiple bonds, helping to spread and reduce
risk.
WeltSparen Asset Management as an Alternative to Bonds
A cost-effective alternative to actively managed bond funds are passively managed bond ETFs
that track the performance of a bond index. WeltSparen’s asset management does not purchase
individual bonds, but instead invests in a globally diversified index fund containing a wide
range of bonds.
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